MARKETING & BROKER PACKET FOR
TRANSACTIONAL RISK INSURANCE
Inserts:
- Transactional Risk Insurance: Why It Should Be Included In Every M&A Analysis
- Risks/Hypothetical Claims Covered Under Transactional Risk Insurance
- Description of Successful Placements of Transactional Risk Insurance
- Features, Pricing, Structure and Submission Requirements for R&W Insurance
- Features, Pricing, Structure and Submission Requirements for Tax Insurance
- Features, Pricing, Structure and Submission Requirements for Pending Litigation Insurance (“PL Insurance”)
- A Message Especially for Brokers
- A Message Especially for Law Firms
Transactional Risk Insurance:
Why It Should Be Considered In Every M&A Analysis
By definition, a sale or acquisition of a business involves change, which brings uncertainty, protracted discussions and negotiations.
The sellers’ representations and warranties serve to reduce much of the uncertainty regarding the state of affairs of the business being acquired. The sellers’ representations and warranties disclose specifically requested facts about legal, operational, financial, tax and related matters concerning the business. The representations provide a basis for the buyer to “walk away” if before closing the transaction the buyer discovers them to be materially inaccurate. The representations also provide a basis for indemnification if after closing the buyer can establish that a representation was untrue.
Therefore, the parties to an acquisition agreement, typically labor over the scope of the representations and warranties, the terms of the indemnification provision, the amount of escrow to be held back in support of the indemnity obligations and related matters.
Now, a series of financial products offered by The Hartford serves to facilitate reaching an accord on these sensitive issues and allows some the risk in a transaction to be transferred to The Hartford. These series of products are collectively referred to as “transactional risk insurance.”
Transactional risk insurance comprises the following three financial products:
- Representations & Warranties Insurance (“R&W Insurance”) – which insures loss resulting from an inaccuracy in the seller’s representations and warranties. R&W Insurance can be Seller-based (indemnifying the seller for its indemnity obligations owed to the Buyer) or Buyer-based (providing first-party coverage to a buyer, in lieu of an increased escrow or indemnification ceiling). A borrower-based policy may also be issued covering the representations made by a borrower to its lender for acquisition financing.
- Tax Insurance – which insures loss resulting from the failure to achieve certain tax consequences expected to result from a transaction
- Pending Litigation insurance – which insures loss resulting from a pending litigation disclosed to the buyer.
Every M&A analysis should consider the utility of transactional risk insurance because it:
- Enhances Bids/Offers,
- Reduces Negotiations,
- Facilitates Acquisition Financing and Asset-Based Loans,
- Reduces Escrows,
- Augments Due Diligence
- Transfers The Risk of Misrepresentation, Adverse Development and/or Adverse Tax Consequences To An Insurer
- (and its not fattening)
If you haven’t already heard about Transactional Risk Insurance, you are not alone. Although it has been sold for more than a decade in the United Kingdom, it has only been offered in the United States for the past three or four years. The Hartford has been offering transactional risk insurance for the past two years and has an in-house staff of tax attorneys, commercial lawyers and a certified public accountant to process requests for insurance.
Please read the other inserts included in this packet in order to learn about The Hartford’s pricing, structure (limits and retention) and underwriting process for transactional risk insurance and other relevant information.
Risks/Hypothetical Claims Covered Under Transactional Risk Insurance
R&W Insurance
- Undisclosed third party claim pending against acquired company
- Tax liabilities owed for prior open years
- Inadequate reserves for inventory or accounts receivables or material contingency
- Impaired asset(s)
- Key contracts with suppliers, customers, employees, lessor or lender need but lack consent
- Capitalization issues, such as a previously redeemed shareholder having the contractual benefit of a “lookback” provision allowing participation in the sale proceeds.
Tax Insurance
- Whether a “tax-free” reorganization will be respected as such
- Whether a net operating losses may be used to offset gain from an asset sale or by a successor company
- Whether a corporate division (e.g., spin-off) will be respected as a “tax-free” transaction
- Whether a subsequent change in control of a company will adversely effect a prior spin-off transaction
- Whether subchapter S status will be respected as such
- Whether REIT status will be respected as such
- Whether partnership status will be respected as such
Pending Litigation
- Any lawsuit whose exposure (probability and magnitude of liability and damages) can be reasonably assessed given the scope of the pleadings, the degree of investigation and discovery to date and related factors
REPRESENTATIVE PLACEMENTS
Representations & Warranties Insurance
FORTUNE 100 COMPANY SELLING NON-CORE BUSINESS
- Situation: Fortune 100 company selling a non-core business division seeks to “book” full amount of gain at time of closing and avoid posting an “acquisition” reserve for any potential indemnification obligation to buyer. Buyer is unaware of seller obtaining R&W insurance policy and, following the sale, seller will be buyer’s largest customer.
- The Hartford Solution:
-Issued Seller-based policy with confidentiality provision covering seller’s indemnification obligation to buyer for breach of R&W in excess of modest retention.
SOFTWARE DEVELOPER ACQUIRES NICHE SOFTWARE CO.
Situation: Software developer acquired a software technology company
from sellers resistant to any escrow and insistent upon a low indemnity
cap.
The Hartford Solution:
-Issued buyer-based policy with retention equal to the indemnity cap.
-Strategic use/benefit: buyer negotiated a reduction in the purchase price
that exceeded the insurance premium in exchange for the low cap and
absence of escrow, thereby using R&W insurance as a “profit center”.
MULTINATIONAL MANUFACTURER OF BRAND NAME FOOD
PRODUCTS ACQUIRES NICHE FOOD MANUFACTURER
Situation: Sellers of closely-held niche food manufacturer seek to reduce
amount of purchase price held in escrow in order to increase proceeds received at closing.
The Hartford Solution:
-Led R&W insurance program with limit of liability equal to amount by which escrow was reduced.
-Strategic use/benefit: selling shareholders used R&W insurance program to increase proceeds they received at closing by more than $30M.
Tax Indemnity Insurance
TRANSFER OF CONTROL FOLLOWING SPIN-OFF OF SUBSIDIARY
- Situation: Company A effectuated a tax-free spin off to its shareholders of Subsidiary X for the purpose of allowing Subsidiary X to effectively raise capital. At least six months thereafter, Company A received an unsolicited, unexpected offer to be purchased at a significant premium to its widely accepted value. Because the offer has come less than two years after the spin off of Subsidiary X, the IRS could challenge the tax-free status and would be entitled to a presumption that the spin-off did not qualify for tax free treatment.
- The Hartford Solution: A Tax Insurance policy to insure Company A (and/or its successor) from tax liability resulting from the spin-off being stripped of its tax-free status.
USING NET OPERATING LOSSES TO AVOID TAX ON CAPITAL GAIN
- Situation: Company A sought to sell two subsidiaries and then sell itself via a merger. The gain on the sale of the subsidiaries would be offset by net operating losses carried on the consolidated tax returns of Company A and its subsidiaries. The respective buyers of Company A and each of its subsidiaries are concerned that the net operating losses (arising from a highly leveraged buy out of Company A) may be challenged with resulting contingent liabilities on each.
- The Hartford Solution: A Tax Insurance policy to insure Company A and each subsidiary (as well as their respective parents, successors and assigns) for the potential tax liability arising out of any challenge to the net operating losses.
CHARACTERIZATION OF PAYMENTS BY BUYER TO SHAREHOLDER EMPLOYEES OF SELLER AS CAPITAL GAIN
- Situation: Company A is about to be purchased by Company B. Some shareholder employees of Company A received promissory notes from Company B as partial payment of the purchase price. The shareholder employees are concerned that the IRS will challenge the characterization of payments of principal under the notes as ordinary income.
- The Hartford Solution: A Tax Indemnity policy to insure the shareholder employees of Company A from any tax liability arising out of a recharacterization of the note payments as ordinary income rather than capital gain.
Features, Pricing, Structure and Submission Requirements for R&W Insurance
Capacity$25,000,000
Minimum RetentionGenerally, lowest of 3-5% of purchase price,
gross assets or annual revenues
PricingGenerally, premium and fees total
4 to 7% of the limits of liability, with all, if any,
identified “heightened risk” either excluded,
modified or subject to additional retention
and/or premium. Surplus lines tax is additional.
TermUp to six years
Matters CoveredGenerally, all representations other than environmental matters and identified heightened risks
Submission RequirementsAcquisition Agreement (near final), 3 years financial statements of company being acquired, identity of potential insured, requested limits/program, and (if available) motivation for insurance and expected date of inception.
ContactsKenneth De Berry
-Phone: (212) 277- 0441
-Fax: (917) 464-2429
-Email:
In-House ProfessionalsDavid S. De Berry, Esq., First Vice President
Kenneth W. De Berry, CPA, First Vice President
Martin Conroy, Esq., Vice President
David M. Anderson, Esq., Vice President
Features, Pricing, Structure and Submission Requirements for Tax Insurance
Capacity$25,000,000
Minimum RetentionGenerally, most probable settlement value with minimum of 10% of the amount at risk.
PricingGenerally, premium and fees total
7 to 11% of the limits of liability. Surplus lines tax is additional.
TermUp to six years
Matters CoveredGenerally, U.S. tax liability, interest, penalties and gross-up (taxes on receipt of proceeds). May also include defense costs and state and local taxes.
Submission RequirementsDescription of the transaction and contemplated tax treatment. Calculation of the amount at risk. If and as appropriate, chronology of events and copies of relevant agreements and board minutes. Audit history of company to be insured. If available, tax opinion and/or tax memorandum addressing the risk. Lastly, (if available) motivation for insurance and expected date of inception.
ContactDavid Anderson, Esq.
-Phone: (212) 277- 0488
-Fax: (917) 464-6242
-Email:
In-House ProfessionalsDavid S. De Berry, Esq., First Vice President
Kenneth W. De Berry, CPA, First Vice President
Martin Conroy, Esq., Vice President
David M. Anderson, Esq., Vice President
Features, Pricing, Structure and Submission Requirements for Pending Litigation Insurance
Capacity$15,000,000
Minimum RetentionGenerally, most probable settlement value plus expected defense fees with minimum of 10% of the amount of risk.
PricingGenerally, premium and fees total
10%+ of the limits of liability.
Surplus lines tax is additional.
TermUp to six years (Typically, one year, but with
immediate claim)
Submission RequirementsPleadings, procedural history and, to the extent available: substantive motions (briefs, affidavits and orders), expert opinions, damage analysis, current insurance coverage for the risk (if any), motivation for insurance and expected date of inception.
ContactMartin Conroy, Esq.
-Phone: (212) 277- 0449
-Fax: (917) 464-6144
-Email:
In-House ProfessionalsDavid S. De Berry, Esq., First Vice President
Kenneth W. De Berry, CPA, First Vice President
Martin Conroy, Esq., Vice President
David M. Anderson, Esq., Vice President
A Message Especially for Brokers
Why The Hartford?
The Hartford’s transactional risk insurance offers several distinctive advantages for brokers and their clients. In a nutshell, we offer:
-Exemplary service
-Superior coverage
-Competitive commissions
Exemplary Service
It’s all about the people and the process. The Hartford’s transactional risk insurance team is dedicated to:
-Integrity: We are honest about our assessment of a risk and will stand behind our promises. The transactional risk insurance team is comprised of individuals who are committed to being fair and honest in their business dealings.
-Sophistication: Because we are staffed with in-house litigators, tax attorneys, an accountant and commercial lawyers, we are able to address complex issues expeditiously.
-Efficiency: We have forms and procedures designed to facilitate, and not hinder, the closing of a transaction. Your client can expect a conditional binder with attached form of policy at least one day before the closing, pre-closing or inception date.
Selected Policy Features
R&W Insurance
Claims Made Coverage:
- The Hartford typically extends the policy period to six years;
- The Hartford allows for a "discovery" (notice of potential claim) to be filed during the policy period
Key Coverage Terms:
- The Hartford will cover the representations made as of the time of closing pursuant to a bring-down certification.
- The Hartford can issue a "seller-based" or a "buyer-based" coverage (and can issue forms tailored for multiple insureds, mergers and two-step mergers);
- The seller-based coverage would insure, subject to its terms and conditions, loss that the seller is legally obligated to pay the buyer pursuant to the acquisition agreement;
- The coverage is freely assignable and portable (if acquired company or acquirer is subsequently sold or if seller is sold).
Exclusions:
- The Hartford's "knowledge" exclusion is far more narrower than that contained in some of our competitors’ policies; The Hartford does not exclude loss arising out of facts which the insured had knowledge which could reasonably have been expected to give rise to a breach (in the absence of actual knowledge)
- The Hartford's "knowledge" exclusion would specify name individuals whose knowledge would be attributable to the sellers.
Defense costs:
- The Hartford would advance defense costs after the Retention is satisfied.
Tax Insurance
Claims Made Coverage:
- The Hartford typically extends the policy period to six years;
- The Hartford allows for a "discovery" (notice of potential claim) to be filed during the policy period if a tax year insured is then under audit or extension.
Key Coverage Terms:
- The Hartford will tailor its policy to address the specific tax risks sought to be transferred.
- The Hartford will not unreasonably withhold consent to a request to advance the disputed taxes on the condition that a refund will be filed and prosecuted in the U.S. District Court or Federal Claims Court.
Exclusions & Conditions:
- The Hartford's exclusion and conditions are generally limited to matters that are within the control of the taxpayer.
- If penalties are not sought to be insured, The Hartford may insure the risk without a signed opinion.
Defense costs:
- The Hartford would advance defense costs after the Retention is satisfied.
Pending Litigation
These policies tend not to be comparable since they are basic indemnity policies manuscripted for a particular lawsuit.
Commissions
The Hartford pays commissions commensurate with the “value added” and efforts required to bring the parties to an accord with the understanding that transactional risk insurance typically pays higher commissions than other financial products.
“Hit Ratios”, Submission Materials & Initial Information
We appreciate your business and understand the importance of clearly articulating our underwriting criteria to facilitate proper screening.
We believe that satisfactory “hit ratios” can be maintained for transactional risk insurance if (1) the potential insured is qualified and (2) the potential transaction is qualified.
A potential insured is qualified if the person who will have the ultimate decision-making responsibility for purchasing the insurance is in direct communications with the broker, has provided the information noted below and, after being advised of the basic structure, price and process has indicated that he or she intends to purchase the coverage. The transaction is qualified if it appears more likely than not that the transaction will close.
R&W Insurance
Initial submissions should simply include the acquisition agreement and financial statements of the acquired company; however, the following initial information would greatly facilitate an accurate sense of whether the matter is likely to bind with The Hartford and would help “qualify” the potential insured:
(i)obtain background information such as who the client is if not already apparent (e.g., one of several shareholders), who the contact is for the producer, how the matter came to the broker, etc.
(ii)inquire why seller decided to sell the business and why buyer decided to buy the business;
(iii)obtain timetable for transaction (you may need to help the broker distinguish among the date of announcing, the date of signing and the date of closing);
(iv)confirm that you have received a complete submission (or advise to what is missing if a near-complete agreement and three years audited financial statements have not been forwarded);
(v)identify motivation for seeking insurance (begin with how it was first discussed by the parties); and
(vi)determine if the client desires suggested contract language obligating the parties to cooperate in obtaining the coverage, etc.
Tax Insurance
The initial submission should include:
- a description of the transaction
- a memorandum (or opinion) of the tax issues to be insured
- a calculation of the expected loss if the expected tax results are not realized
Generally, The Hartford is not inclined to insure the following types of tax matters:
-a tax shelter (generally, an investment that would not be made by a prudent person, or would not have been so structured, but for the tax benefits);
-a matter that predominantly depends upon a subjective valuation (such as an appraisal)
-a request to provide coverage for a change in the tax laws.
Pending Litigation Insurance
Generally, an initial submission should include the pleadings and any additional materials that may help us evaluate the risk fairly. Accordingly, a lawsuit should be sufficiently matured so that investigation and discovery has taken place.
A Message Especially for Law Firms
We appreciate that your time is your inventory and that your reputation is your enterprise value. The Hartford is committed to an efficient use of your time in the underwriting process and in according you the appropriate respect when reviewing a transaction. We recognize that you were not retained to represent our interests.